Compounding interest has such a monstrous impact on a teacher’s financial outlook that it’s worth an entire post on its own. You don’t need to understand it, but if it’s going to allow us to retire early, it’s probably worth a look.
Perhaps more importantly, knowing about its power will probably change your relationship with money. It certainly did for me!
In the last post, we referenced compounding interest and it’s impact on doubling your money. Give it a look here, if you haven’t already, then come back.
It probably goes without saying but the more times you double your money, the faster it grows. Compounding interest is the catalyst that gets your money doubling at a much higher rate.
Example of Compounding Interest
Here’s an example of compounding interest with numbers just to let us see it and understand it better.
On average, and for the purposes of this example, invested money returns about 8% interest per year. That’s the rate we’ll use.
That means if you invest 100 dollars. After the first year you would have $108 dollars. The second year however, you would NOT have only 8 more dollars (or $116 total).
Why? Because of compounding interest! You also are earning 8% on the 8 dollars of interest you earned last year. In the second year, you earn 8% of $108.
Instead, after year 2, you would have $116.64.
I know what you’re thinking. You’re thinking, “Yay! 64 more cents! Let me throw a flipping parade! I’ll pay off my mortgage and my student loans in one fell swoop. I’ll book a flight to Tahiti and buy one of the neighboring islands while I’m there! Hooray for the Teacher Double! Let’s hoist him on our shoulders and celebrate him!”
Are you done? Can I finish?
“What ever shall I do,” you continue, “with the money left over after buying the island with the 64 cents I earned from this magical sorcery we call compounding interest? Perhaps I can end world hunger? Or maybe I should provide the necessary infrastructure to all countries in need throughout the world? Maybe I’ll do both?”
Really? Can I go on yet?
Thank you. Bringing us back and fast forwarding a bit, we’ll see compounding interest start to take effect.
Back to the Facts!
Essentially, after 9 years of compounding interest your money will have doubled to $200. Without compounding interest it would equal $172 for a difference of $28.
And before you go off on another sarcastic diatribe, let’s forge on. With compounding interest your money doubles every 9 years. Without it, it takes 12.5 years. That will prove to be crucial over time.
After 18 years, your money, with compounding interest (CI), has doubled again to $400. Without it, it’s $344. I know, not very compelling. But remember the raja from the story in the last post! We need to keep doubling to see the power of it!
Check out this table below on the effects of Compounding Interest (CI) over time.
| Time in Years (# of Doubles with CI) | Amount with CI | Amount w/out CI |
|---|---|---|
| 0 years (0 doubles) | $100 | $100 |
| 9 years (1 double) | $200 | $172 |
| 18 years (2 doubles) | $400 | $344 |
| 27 years (3 doubles) | $800 | $416 |
| 36 years (4 doubles) | $1,600 | $488 |
| 45 years (5 doubles) | $3,200 | $560 (slightly over 2 doubles) |
As you can see the effects become more dramatic over time. It turns out time is another key ingredient that works in conjunction with the compounding interest.
The more time, the more we double.
By the end of the table there is an appreciable difference between the two figures. The one with compounding interest doubled 5 times compared to just over 2 without it.
Now let’s look at, through the eyes of a teacher, what happens when we put more than $100 to work.
A Teacher’s Reaction to A Compounding Example
Last school year, somewhere after the time I decided I was too burnt out to continue teaching, but before the school year ended, I discovered the FIRE (Financial Independence Retire Early) movement and it changed my whole outlook on my career.
Now, rather than burning the candle on both ends for 18 years until I reached my full retirement, I suddenly had a vision to be able to retire in 5-9 years (if that’s what I wanted to do).
I was so excited about it that I organized a few gatherings with my colleagues to hash out some ideas. In one of the gatherings we talked about compounding interest.
I kicked off this meeting by giving one of my colleagues, Mary, a hypothetical situation. Mary’s that tough-love, no BS, kind of teacher that students’ respect/love and her fellow teachers adore. She’s also a ham and was nearest to retirement (mid 50’s?). In short, I thought she’d be a good candidate for the little scenario I was about to give her.
It turns out she was a perfect candidate. There is no way I could capture the brilliance of her performance in writing. A summary will have to suffice, but see if you can envision it.
The Hypothetical Comes to Life!
I called Mary up to the front of our meeting and gave her a hypothetical scenario.
The scenario was this: Mary, Imagine that you are able to go back in time and observe and interact with your 18 year-old self. On that particular day, a stranger comes and presents your 18-year old self with 2 manila envelopes. One of the envelopes, the stranger explains, is stuffed with $10,000 cash the other contains a check made out for $250,000 that can only be cashed once you turn 60. You see your 18-year-old self reaching for the envelope of cash. What do you do?
Her Reaction?
Immediately, Mary’s face got red with anger and her eyes flashed with fiery madness.
“YOU EFFING IDIOT!” she screamed at she grabbed her imaginary self by the ear and started dragging her around the classroom.
Afterwards, most people would swear that they could actually see this imaginary 18-year old Mary being taken to task.
“What the eff are you going to do with that money huh? ” she continued. “Are you going to buy ‘cigarettes and cool clothes and drinks(the drinking age was 18 then)’ for all your friends? Huh? Answer me!”
And she was off! She continued verbally berating and eviscerating her former self before our very eyes. She may have blacked out with anger and forgot we were there. I’m not sure, but it certainly went on for a while.
Finally, her voiced softened to a creepily sweet tone as she stroked the hair of this imaginary being she knew so well. “Or maybe you just want a car? Is that what you want dear? Do you just want to fit in and feel accepted by your friends and you think a car will do that for you right?”
Imaginary Mary sadly nodded her head (I swear it!).
“WRONG!” she exploded. “Now get your butt over there and grab that check or I will smack you into next week!”
After things settled (it took a while!) the point was right there for the plucking…
What’s the Take-Away?
Ultimately, I think the main take-way is this: The financial decisions we make today, have a monumental impact on our financial future.
Mary might have said it like this though: “Don’t spend your money on frivolous crap. It’ll come back and haunt you later.”
Either way you say it I think the math supports it.
Call up any compounding interest calculator on Google. If you put in $10,000 and let it grow at 8% interest (the average rate of return from the market) for 42 years (from Mary’s 18th year to her 60th year) you will have over $250,000 sitting there.
That’s no small thing! And remember Mary’s reaction? It was visceral and it was palpable! She knew her younger self would squander that money away leaving her less options later.
In a matter of minutes, Mary taught us an essential lesson through her past financial mistakes. I want to learn from those so I don’t have the same regrets later.
Take Care of your Future Self!
I think it’s absolutely imperative to look down the line at our future selves and try our best to take care of that person. Teaching is a demanding job, and if the conditions are not favorable, it can take a heavy toll on us.
I’ve found it exceedingly helpful to be able to take a step back this year and regroup. Essentially, rather than buying material goods with my money, I am buying time.
This idea of “buying time” is definitely worth a future post that I’ll link to here when it’s done.
For now, I hope that the example (10,000 turning into 250,000) illustrates that those little amounts really can add up to huge sums.
But here’s the thing! In that example the person only did a one time down payment of $10,000 and never added to it again!
What would happen if we added even more to it each year as our salary increases? Hint: The number will be a lot bigger! We’ll do specifics later as well.
And just to be clear, I just came to this conclusion mere months ago. That means my past is littered with spending regrets. You simply can’t go down this road without regrets and you can only change the decisions you make moving forward. Don’t sweat it. You’re in good company!
I hope this post and the future ones help to illustrate the power of saving your money and submitting it to the massive power of compounding interest.
Thanks for reading and, as always, I’d love to hear your thoughts on the matter. All questions and comments are welcome below!
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